Dear Liz: I'm self-employed and have a Simplified Employee Pension account. Every year I borrow from an equity line to contribute the maximum to this account. My wife questions whether we are ahead by doing this. I say yes because we obviously save on the amount we pay in taxes and are paying only 5.25% on the equity line. We hope to pay off the loan in six months, plus we get to write off the interest. Is this a good plan?
Answer: This is one of those ideas that seem great in theory but have all kinds of potential pitfalls, said financial planner Delia Fernandez of Long Beach.
"You're adding debt without knowing when you can pay it off," Fernandez said. "The interest rate on the loan is variable, which could quickly change in today's credit environment, and you're self-employed, which is inherently risky."
Next year, file for an extension to delay your tax return due date to Oct. 15. That would give you the six months you think you need to come up with the money.
This approach costs you nothing, "and you can always make deposits to your SEP sooner if business is good," Fernandez said.
"What's more, if finances get tight, you haven't added to debt. In short, it's a strategy that gives you the most flexibility with absolutely no cost, an ideal plan for a business owner."
Try not to raid retirement funds
Dear Liz: After reading some of your columns on bankruptcy, I realize that's the route we should have taken. Instead, because of a four-year period of unemployment and underemployment, we used up our retirement savings and lost our home to foreclosure. We have made arrangements to pay off our remaining bills at zero or low interest over the next five years. We are now in our mid-50s with our youngest child starting college. We have some good high-earning years left, fortunately, and would really like to get back in the housing market plus save for retirement. How do we start?
Answer: It's unfortunate you used your retirement savings, which, as you now know, would have been protected from creditors in a bankruptcy filing. Retirement savings should be left alone for retirement and used only as a last resort. Yet far too many people dip into them in a frantic effort to pay off bills, continue a too-expensive lifestyle or to save a home they really can't afford in the first place.
Your primary focus needs to be maximizing retirement savings. Unfortunately, there's no way, short of winning the lottery, to make up for lost time, which is what your spent retirement funds represent. Typically people need to start saving by age 35 or 40 and to continue uninterrupted to afford a truly comfortable retirement.
That doesn't mean your situation is hopeless, but you'll need to put aside a substantial portion of your pay, probably 20% or more, and be willing to work past normal retirement ages to ensure you have enough to cover the basics in your old age. There are plenty of retirement calculators to help you figure out the numbers; one to try is at moneycentral.msn.com/retire/planner.aspx.
If you pay bills on time and use credit responsibly, you may be able to qualify for another mortgage in a year or two. Make sure the home you buy is well within your means and that its expenses don't prevent you from saving for retirement.
Finally, you need to practice a bit of tough love with your youngest to make sure her education is affordable. Given your financial situation, she probably should opt for a public rather than a private university and look for scholarships. If money needs to be borrowed to pay tuition, she should be the one taking on the loans, not you. After all, student loans are still in plentiful supply, but no one's going to lend you money for retirement.
How much the FDIC insures
Dear Liz: I'm concerned about banks' recent problems with sub-prime lending. I have three accounts at one bank, including $50,000 in a certificate of deposit, $55,000 in a money market account and $25,000 in a checking account. The bank says each account is covered to $100,000. Is this true?
Answer: The basic Federal Deposit Insurance Corp. coverage amount is $100,000 per depositor, not per account. There are ways to get more coverage than that if you have accounts in what the FDIC calls "different ownership categories," such as joint accounts or certain retirement accounts. For more details, check out the information at www.fdic.gov /deposit.
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